Commercial mortgages

If you’re looking to expand your business, or the cost of renting commercial premises has become too great, you may be considering investing in a property. Chances are, you’ll be looking to explore the range of commercial mortgage options on offer as a potential source of business finance and you’ll quickly discover that there’s a lot to be aware of.

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Key points to consider

With a commercial mortgage, you won’t have any sudden or unexpected rent increases, but obviously monthly repayments could go up if you have a variable rate deal. You may, however, be able to get a fixed rate mortgage for a period of time.

If the property increases in value, your business capital will go up and interest repayments on a commercial mortgage are tax deductible. You could possibly rent a portion of the premises to another company to help meet those monthly repayments, if your lender agrees to such an arrangement.

Repayment options are not unlike those found in the residential market, but there’s usually a slightly higher rate of interest, as commercial mortgages are perceived as higher-risk. It’s prudent to be able to offset this risk with as large a deposit as possible – at least 20%.

And as well as the standard valuation, arrangement, and legal fees, there can be additional costs associated with a commercial mortgage, so it’s worth seeking clarification from a lender or broker.

There’s a wealth of commercial mortgage providers out there, from the main high street banks to specialist lenders, so it’s worth searching the market to find one that ticks all your boxes — for the right price.

Types

Broadly speaking, commercial mortgages can be used for three purposes:

Owner-occupied

Commercial mortgages for owner-occupiers are usually for two business situations: either a company wants to purchase the premises where it currently operates, or it wants to buy a new premises to move into.

Residential buy-to-let

Another common scenario for commercial mortgages is the purchase of residential property to be let out. This area is commonly used by professional landlords with a property portfolio, as well as buy-to-let limited companies set up for the same purpose.

Commercial buy-to-let

Similar to the above, you can use commercial mortgages for commercial buy-to-lets as well. For example, you might want to purchase a warehouse via your company and let it out to another business. Although this type of mortgage is similar to residential buy-to-let, the lender will look at different factors because in general it’s more difficult to rent out commercial properties.

Lenders

There is a wide range of lenders offering commercial mortgages, each with their own pros and cons.

High-street banks

The obvious benefits of the major banks are that if you’re eligible, their rates are tough to beat. They’ll often lend against the OMV and offer quite high LTV, which means you may get a larger mortgage, and the big banks are also more likely to have shorter and less onerous tie-in periods.

The downsides are that their criteria can be more difficult to satisfy. They require a fairly high DSCR, which means you need a higher income to service the same amount of debt than you would with other lenders, and if you have recent credit issues they’ll often turn down your application outright. Also, the process of applying for a commercial mortgage can take a long time with the major banks, with decisions regularly taking more than 3 months.

Challenger banks

The challenger banks generally have a greater appetite to do business, and can help some of the businesses that their high-street cousins can’t. First, their DSCR requirements are usually lower, which means their income threshold for commercial mortgages can be easier to satisfy. They will also consider applications with credit issues in the last two years, which the major banks won’t usually do.

Challengers sometimes offer interest-only repayment options up to the maximum LTV, which makes sense for businesses who buy their premises for cashflow reasons rather than capital gains — for example where the interest-only mortgage payment would be less per month than their current rental payments.

The downsides of the challengers come down to cost and flexibility — in general, they’re more expensive than the high-street banks, and will often have higher exit fees for the duration of the mortgage, which may limit your options if your future is uncertain.

Challengers may also agree the commercial mortgage amount based on a 180-day marketing period rather than the OMV, which can potentially lower the amount you can borrow.

Niche lenders and specialists

Compared to both types of bank, the smaller specialist lenders are a lot more flexible overall. If you want a commercial mortgage but haven’t been in business long, the niche lenders may be your best bet, because they are often prepared to lend to shorter trading histories and have lower affordability criteria (DSCR). In some cases, it’s even possible to use projections instead of trading history if they’ve been signed off by an accountant.

The specialist lenders may also be more flexible in terms of location, considering applications for mortgages in most areas of the UK and in some cases even offshore territories. These situations will be looked at on a case-by-case basis, however.

As you might expect, the downside of these types of lenders is the cost — they’re usually more expensive commercial mortgages than those you’ll get from the banks. The smaller lenders tend to lend against the FSV too, which is usually lower than OMV and therefore can significantly reduce the percentage of the property value you can borrow.

They’ll also have longer terms, and more restrictive exit fees. For example, you may have a tie-in period of 8 years on a 10-year mortgage with exit fees ranging from 2–6% — significantly more restrictive than the banks. Having said that, if your situation means you’re only eligible for the specialist lenders, the comparison with major banks is irrelevant.

Eligibility & Criteria

Trading history is important

When it comes to getting a business mortgage, your trading history matters. Lenders want to know that your business can afford the mortgage and will be able to repay it. If you run a limited company that’s currently trading, you’ll need at least 3 years of filed accounts to be eligible for the high-street banks, and at least 2 years of accounts for the challengers.

If you’re thinking of buying a property to start a business, you’ll need to have a significant lump sum to put in yourself. Typical loan-to-value ratios for a brand new business with no trading history will be a maximum of 50% of the purchase price, so to purchase a property worth £200,000 you’d need a minimum of £100,000.

For professional landlords looking to get commercial mortgages for residential rental property, you’ll need to demonstrate previous experience in this area, usually at least 1 year.

What you do with the property matters

Not all commercial mortgages are created equal, and how you use the property makes a difference to both the interest rate you’ll pay, and how much you can borrow.

For example, owner-occupied businesses such as offices or shops can normally get a maximum loan-to-value of around 80%. But, if you decide you want to split your office building into smaller units and lease some of these, then that’s a different story. Now you’ve crossed over from an owner-occupied business to a commercial buy-to-let business, and your maximum LTV drops to 75%. What’s more, your interest rate goes up too, so now you’re looking at rates starting from 3.00% over the Bank of England base rate.

Location, location, location

If your company already owns lots of properties in the same area of the country, getting a new commercial mortgage might be difficult for the banks because you’ve reached what they call the ‘concentration limit’. The idea is that if the market in that area goes down, you’re much more exposed than you would be with a portfolio of properties spread all over the country.

Planning permission is also important, because it has strong implications for the future profitability of the site. However, some of the challenger banks and niche lenders will consider commercial mortgage applications without planning permission.

There’s always an exception to the rule

In the UK there are over 70 lenders who specialise in business mortgages, from high street banks through to niche lenders. If you can put together the right business case, you can often find a lender who is willing to offer you a business mortgage, even if on paper you might not meet all the criteria.

Security

Lenders often require security when offering commercial mortgages — it helps to offset their risk when providing large mortgages for offices, warehouses or other commercial premises. These tips should help clarify some of the common doubts we’ve come across in the minds of buyers.

1. Understand how much equity is in your security being offered

Unfortunately, it’s not a simple case of using your property or asset’s market value as a guide to what you can borrow. The more accurate gauge is to use the remaining equity in the property. Lenders assess different valuations – often, the forced sale value – and they take into account any outstanding debt against the security, for example previous debentures or charges. In general, you will need to have remaining equity of at least 75% of the value of the property you are looking to buy.

2. Insufficient cash deposits to cover the rest of the purchase

In this case, lenders may ask for additional security to help you purchase the property. It is often the case that a lot of your cashflow is tied up in business operations or existing property, so providing additional security can be a good option for those businesses and sectors that find themselves asset-rich but cash-poor.

3. There are lots of lenders in the market and each prefer different assets

This is a key point that many prospective buyers don’t fully understand, and it is a major reason for using a service like Funding Options. To secure large mortgages, different lenders will only accept certain types of assets. For instance, some lenders prefer taking second charges, rather than the first charge, against property. Others prefer to take certain types of property as collateral, like residential properties, pubs or warehouses. They even have different preferences when it comes to using sites and land as security, and the location of the asset can also be a factor.

4. The extra fees associated with buying new property

Don’t forget that you will also have to include the valuation fees when using security in any funds lent — this is in addition to the usual legal and arrangement fees. The Funding Options team can help to clarify what you should expect in terms of fees as the process nears completion and, in some cases, we may even have access to cheaper alternatives for you.

How to choose

The sheer variety of commercial mortgage options on the market offers great competition for the finance that you can obtain. Here’s a quick run-down of the important things to bear in mind when looking for a commercial mortgage.

Fixed Rate vs. Variable Rate

You can get fixed rate mortgages for a period of time which ensures your monthly repayments do not increase, there are variable rates which can change, and there are even “blended” rates (a mix of the two). This is an important choice, because it determines not only your monthly payment amount, but also how much equity you’ll build up in the purchased property, and how quickly.

Stamp duty

Stamp duty land tax is payable on properties that cost £150,000 or more. The amount your business pays is a percentage of the purchase price of the property. Your accountant can best advise with regards to your tax liabilities.

Interest Rates

Commercial mortgage interest rates can be fixed against the base rate or the LIBOR (the rate at which banks lend to each other). In addition, lenders will require a cash deposit or additional security which will help offset the risk.

Renting Part of Your Premises

This can be a viable option and the rent can help with your monthly mortgage repayments. Due to its complex nature, it would be recommended to speak to one of our business finance experts to explore this great option – and see if it would suit you.

Extra Fees

You will have to pay a small percentage for arrangement and legal fees when you purchase commercial property, so it’s worth speaking to the lender and an intermediary like Funding Options who can explain these terms simply and ensure you know the full cost. It is also worth considering refurbishment costs, with the more organised factoring this into initial costs when selecting their property.

Why use a mortgage broker?

Commercial mortgages are complex and regulated products. You typically require higher deposits than residential loans, and a financial provider will need to assess your application.

Mortgage brokers and whole-of-market intermediaries like Funding Options are here to assist you on your journey to securing a commercial mortgage. Here are six reasons a mortgage intermediary can help:

Expertise

We’re experts in the field, with many years of experience in sourcing the right mortgages for our clients’ needs. We’ll help you find the best way to finance your plans, and while it’s beneficial to do some price comparison yourself, you don’t want to be applying for finance at every bank and lender you come across, as it may affect your credit rating if you’re rejected.

Access to the whole market

As experienced professionals, intermediaries have the knowledge of all the latest products and innovations in property finance. We assess your case not just for the high street banks, but for alternative providers too, so you have access to a wide range of products to see if they could work for you.

Relationships with lenders

Mortgage intermediaries have good relationships with lenders and the people that actually make the final calls, so your application will be underwritten with the best possible case for success being made. Sometimes, online forms just don’t have the relevant fields in which to show you can run your company successfully — we’ll make sure your case is presented fairly.

We’re on your side

Intermediaries are there to work for you, to get the right deal for your situation. We’re impartial and objective, and we’re happy to spend time guiding you through all the complex terms and conditions you should expect with a mortgage. That means you’ll be aware of all the repayments you need to make, alongside any extra charges or fees, and you can feel safe in the knowledge that you’ve got the right mortgage for your situation.

Honest explanations

Perhaps a commercial mortgage isn’t right for you at moment. If so, instead of wasting your time, we’ll explain to you exactly why you wouldn’t be accepted, and explore all your alternative options. Often it’s better to know immediately that you’re on the wrong track, rather than spend weeks in the application process just to be declined at the end of it.

We’re a one-stop-shop

As a business owner, your time is limited, and we know you’ve got other things on your mind. While you may want to evaluate dozens of financial providers on the market yourself, with an intermediary you can concentrate on running the business and let the experts do their job — saving you time and energy.

Glossary

Buy-to-let (BTL)

A property which you want to purchase with the aim of letting it out to another party

Debt service coverage ratio (DSCR)

A measure of the cashflow you have available to pay your debt obligations — in other words, the ratio of your monthly repayment amount versus your overall cashflow position.

Forced Sale Value (FSV)

The asking price you could achieve if you were forced to sell the property as soon as possible. Forced sale value is usually lower than Open Market Value because you wouldn’t have time to wait for the best offer to come in.

Loan-to-value (LTV)

The ratio of the amount you want to borrow versus the total value of the property. For example, to purchase a property worth £1million at an LTV of 75% would mean your mortgage covered £750,000 and you’d have to put in £250,000 yourself.

LTV is an important metric in commercial property finance because it determines how much of a buffer the lender has between the potential sale price and the amount lent, and therefore has implications for the risk of the deal.

Open Market Value (OMV)

The asking price you could achieve if you could afford to wait for a few months to sell the property. Open market value is usually higher than Forced Sale Value because you have time to wait for the best offer to come in.

Planning Permission (PP)

Formal legal permission from a local authority for the development or alteration of property, commonly needed for most commercial and residential developments.

Standard Variable Rate (SVR)

The variable interest rate of a mortgage which is determined by the mortgage lender’s discretion, rather than the Bank of England Base Rate.